Monday, 12 December 2016

Fitch: ECB Shows Inflation Commitment, but GDP Impact Diminishes

The ECB’s decision to extend its asset purchase programme (APP) beyond March next year once again demonstrates its commitment to its inflation target, although the extended programme is likely to have diminishing impacts on the real economy, Fitch Ratings says.

The ECB said on Thursday that asset purchases would continue until the end of 2017 at a lower monthly rate of EUR60bn (monthly purchases to March 2017 will be maintained at EUR80bn). ECB president Mario Draghi emphasised that “tapering” was not discussed and the ECB said that the APP’s size and duration could be increased “if the outlook becomes less favourable or if financial conditions become inconsistent with further progress towards a sustained adjustment of? inflation.” We think this signals a strong commitment to higher monthly purchases after March, if necessary, and underlines how far away the ECB is from beginning to consider an outright exit from asset purchases.

The announcement is in line with our expectation that the ECB would extend the APP by six to nine months in response to weak domestic price pressure and a still subdued inflation outlook. The main refinancing rate and deposit rate were unchanged.

To facilitate the extension, purchases under the public-sector programme can include bonds with a remaining maturity of one year, down from two years. Purchases of eligible securities with a yield-to-maturity below the ECB’s deposit rate will be permitted “to the extent necessary”. Without parameter changes, we estimate that, based on current yield curve, the stock of eligible bonds would have been exhausted in November 2017.

Eurozone inflation expectations have increased in recent months. Surveys of professional forecasters continue to indicate a gradual return of inflation to the ECB’s target of close to, but below, 2% over the coming years. Market-based indicators (five-year/five-year forwards) have risen to the highest level since the ECB launched quantitative easing (QE) in March 2015.

We think the direct benefit to the real economy from ECB QE is diminishing as the programme approaches its third year, not least due to concerns about the impact of very low or negative rates on banks’ ability to lend. Moreover, as headline inflation picks up (we forecast CPI at 1.3% at end-2017, from 1.0% at end-2016, partly due to oil price base effects), low nominal wage growth will weigh on real household incomes.

Our 2017 eurozone real GDP growth forecast of 1.4% (lower than the ECB’s 1.7%) assumed QE extension and parameter adjustment. Growth will be supported by a more balanced fiscal-monetary policy mix. A slight further easing of the fiscal stance will reduce the pressure on the ECB to provide monetary policy stimulus. The European Commission forecasts the eurozone cyclically adjusted primary balance to fall to 0.9% in 2017 from 1.0% in 2016.